Final answer:
The unreasonably high portion of a shareholder-employee's salary increases the taxable income of the corporation, as it disallows excess compensation from being deducted. The individual still pays tax on the whole salary and payroll tax, whereas the corporation faces higher taxes due to the adjustments.
Step-by-step explanation:
The portion of a shareholder-employee's salary deemed unreasonable affects a corporation's taxable income rather than the individual's gross income. This is because when a salary is considered unreasonable, it implies that the salary may be inflated to lower the corporation's profits, thereby reducing corporate income tax liability. However, this part of the salary is added back into the corporation's earnings, increasing its taxable income.
For the shareholder-employee, their gross income includes all of their compensation, regardless of what portion is later labeled unreasonable. As such, they will still pay individual income tax on their full salary, in addition to payroll tax on their wages. Corporate income taxes are levied on the adjusted profits of the business, which will be higher if excessive compensation is disallowed as a deductible expense.
While the tax schedule shows that an individual's tax liabilities increase with higher income, in the context of corporate taxation, ensuring reasonable compensation can avoid issues such as increased taxation or disputes with tax authorities over inflated deductions.